- As war drags on, market stagflation worries rise
- Europe, parts of Asia seen as especially vulnerable
- US economy strong but inflation risks persist
- China an outlier, for now
LONDON, April 30 (Reuters) - Financial markets are finding it harder to look past the rising economic costs of the Iran war as the continued closure of the Strait of Hormuz prolongs the world's biggest-ever disruption to energy supplies.
Two months into the conflict, the global economy faces a toxic mix of slowing growth and high inflation - stagflation.
Even as tech stocks lift world shares, analysts warn that the longer Hormuz remains shut, the greater the recession risk for energy-importing regions. Oil hit a four-year high on Thursday above $120 per barrel .
"The probability of a recession in Europe, the UK, and parts of Asia, is higher than is priced into equity markets," said RBC BlueBay's head of market strategy, Mike Bell.
Here is how the risks are shaping up across markets:
OIL WATCH
Oil remains the key barometer.
Brent crude is more than 65% above pre-war levels, and continues to rise as the war drags on. High energy prices threaten growth by squeezing consumers and companies while fuelling inflation.
Citi estimates an adverse scenario pushing Brent prices to $120 through year-end could cut global growth to between 1.5% and 2% and lift headline inflation to nearly 5%.
"The probability of a recession in Europe, the UK, and parts of Asia, is higher than is priced into equity markets," said RBC BlueBay's head of market strategy, Mike Bell.
Here is how the risks are shaping up across markets:
OIL WATCH
Oil remains the key barometer.
Brent crude is more than 65% above pre-war levels, and continues to rise as the war drags on. High energy prices threaten growth by squeezing consumers and companies while fuelling inflation.
Citi estimates an adverse scenario pushing Brent prices to $120 through year-end could cut global growth to between 1.5% and 2% and lift headline inflation to nearly 5%.
FINANCIAL CONDITIONS
The shock is tightening overall financial conditions across developed markets, though the impact remains limited in many countries, according to widely tracked Goldman Sachs indexes.
Market-based measures - which track how asset prices affect funding availability and are seen as a predictor of future growth - tightened to their most restrictive since last spring in the U.S. in March.
They then reversed that move, helped by April's equity rally, but have started tightening again, Goldman's data shows.
Conditions have tightened modestly in the euro zone and Japan, driven by rising borrowing costs and falling equities.
Britain stands out, with a much sharper tightening that points to a heavier growth hit.
U.S. FACES MORE OF AN INFLATION PROBLEM
The impact varies by exposure to energy flows through Hormuz. In the U.S., gas prices are now below pre-war levels.
Jefferies chief European economist Mohit Kumar said both the scale and nature of the stagflation shock differ across regions.
"Inflation will still be higher in the U.S. but that's an oil price impact, the impact on growth is much less in the U.S. than Europe."
U.S. business activity picked up in April, though output prices jumped. Consumer inflation expectations for the year ahead jumped to 4.7% this month from 3.8% in March, while market-based gauges have also moved higher , .
JPMorgan CEO Jamie Dimon said this week the worst-case scenario of stagflation remained.
EUROPE IN A TIGHT SPOT
Europe's reliance on energy imports leaves it especially vulnerable, with data already pointing to a stagflationary hit.
Data on Thursday showed euro zone inflation rose to 3% in April while the economy grew just 0.1% in the first quarter. Contracting business activity, tighter bank lending criteria and surging inflation expectations signal mounting pressure.
Germany's IMK institute sees a 34% chance the bloc's largest economy slips into recession in the second quarter, up from 12% in March.
ING's head of global macro Carsten Brzeski said another month of Hormuz disruption would likely trigger at least a technical euro zone recession.
UK business activity has held up better so far, but risks are rising. The IMF hit Britain with the biggest growth downgrade among rich economies.
Reflecting inflation worries, borrowing costs in Europe have risen faster than elsewhere as traders bet on higher UK and euro zone rates. Britain's two-year yields are up a percentage point since the war began.
Equity markets are down around 5% in both the euro zone and Britain, but U.S. shares have risen.
ASIA HARD HIT, CHINA THE OUTLIER
Asia, which typically takes about 80% of Gulf oil exports and 90% of LNG shipments, is bearing the brunt. Parts of South and Southeast Asia are already facing energy shortages.
Foreign investors are pulling out of Thailand, the Philippines is among the hardest hit, and Indian companies could be under pressure.
Elsewhere, the Bank of Japan raised its inflation forecasts and looks set to raise rates.
China is the exception. Backed by ample oil reserves and a diversified energy mix, it grew 5% in the first quarter. Investors are betting on Chinese battery and electric vehicle companies, while low inflation has helped Chinese bonds rise as others fell.
Still, China is not immune. Higher energy costs could squeeze already thin factory margins just as global demand for its exports slows.
Reporting by Alun John, Yoruk Bahceli and Dhara Ranasinghe. Editing by Mark Potter
Source: Reuters